May 31, 2005
DUALISM IN EXTREMUS
France is said by some to be no friend to the United States on matters geopolitical, but when it comes to foreign exchange it's hard to imagine a more obliging partner. Granted, the current French aid to the dollar is incidental, courtesy of Gallic independence in the form of France's rejection of the European Union's constitution on Sunday. But from a trader's perspective, a rose by any other name would smell as sweet.
By the same logic, albeit in reverse, gold bugs are less than happy with the French dispensing of the constitutional referendum over the weekend. Indeed, whatever helps the greenback necessarily hurts the precious metal. And in the wake of the French vote, the euro has fallen on hard times, dropping to lows against the dollar today not seen since last October. The flip side of a weak euro is a strong dollar, which in turn translates into lower gold prices. The dollar and gold are, as the statisticians like to say, negatively correlated.
It wasn't supposed to be like this, to listen to the gold bugs. The American government has the large and growing fiscal budget deficit. The U.S. harbors the world's greatest trade deficit as well. This, the supporters of barbaric metal say, should boost the fortunes of gold.
And boost it has, until recently. Gold, after climbing more than 25% in the final six months of 2004, has subsequently suffered a crisis of confidence. This year through today's close, gold has dropped 4.5%. Until Sunday, the decline was thought to be temporary, associated with the rebound in the dollar. Hardly great news, but a rebounding dollar was surely temporary, right? The fiscal and trade deficits of American mintage would eventually take their toll. Nothing ever moves down in a straight line. Let the traders have their fun with the buck for now. The comeuppance of the greenback would soon return, the promoters of gold's attributes explained.
But then the French threw a wrench into the precious metal's machine. Traders are less concerned with the twin deficits and more with tectonic plates that support the euro. In short, selling the dollar is yesterday's excuse for fear and loathing on the forex trail. Financial justice, we're told, is in abeyance.
In its place comes euro phobia. If the French can reject Europe's constitution, what other sacred cows can be vanquished?
Perhaps the Dutch voters will provide a hint. The Netherlands votes tomorrow on the European constitution, and polls suggest that another "no" is coming. What might it bring? The Scotsman's chief political correspondent writes today that "a second repudiation within a week will be a devastating setback for the constitution, adding to the pressure on the leaders of the 25-member EU to reconsider the direction of European integration when they gather for a summit in Brussels in two weeks."
Technically, it doesn't matter how the Dutch vote, since approval of the constitution requires a consensus "yes," and the French have already seen fit to discard the document's future in its present form. Perhaps a rewrite of the constitution is coming, which will deliver another round of voting. But that's months, if not years away, if at all, and for the moment nobody can think that far in advance. As such, another resounding no from Holland threatens to raise the degree of anxiety about the euro and spawn a deeper, longer-lasting selloff than imagined just yesterday.
Gold bugs, being readers of newspapers like everyone else, are scrambling to justify staying bullish on the metal. Chief among them is Peter Schiff, president of Euro Pacific Capital. Writing today on the firm's web site, Schiff all but dismisses the dollar's latest rally as something less than enlightened. "The French 'no' vote on the European constitution, which has created political uncertainty in Europe, has produced the reflexive, and ironic 'flight to quality' into the U.S. dollar." But the associated logic is less than airtight, he charges. "As currency traders focus their attention on potential future problems for the European Union, they lose site of current and more acute problems confronting the United States. It is ironic that the currency of the world’s biggest debtor nation is still the 'safe haven' of choice when concerns arise regarding superior currencies of creditor nations."
But all hope for the gold bugs isn't lost. While traders of bullion have registered their skepticism today by selling the metal, gold-mining shares are sending a somewhat different message. The Philadelphia Stock Exchange Gold and Silver Index, a popular measure of listed gold-mining shares, is showing determination of late in moving higher. After a sharp sell-off this morning, the index clawed its way back to a petite loss on the day. Meanwhile, the Philly Gold & Silver index has jumped 10% since May 16, vs. a slight loss in bullion over that stretch. The gold market, in short, is of two minds. But which one's right?
Bifurcated messages, in fact, are all the rage these days. The bond market's rally of late, which dropped the yield on the 10-year Treasury to below 4% today for the first time since February, suggests a slowdown in the economy, as does today's news of the sharp drop in the Chicago Purchasing Managers report for May. But then there's the bullish aura connected with the S&P 500's recent rise, which coincides with today's update on consumer confidence, which the Conference Board says jumped sharply higher in May.
Anything's possible in the capital markets. And that, it seems, is part of the problem at the moment.
Posted by jp at May 31, 2005 6:53 PM
Well, in the immediate sense, the euro is in competition with the dollar. And not just in the sense of its Fx pairing. Remember when Saddam had wanted to be paid for oil with euros?
No viable EU to back up the euro and flush the confidence. Bonus for the dollar.
Posted by: Ray at June 1, 2005 11:34 PM
Interesting point of view regarding the safe have currency status that the U.S. is currently enjoying. It adds a different perspective when you consider the debt situation of the two countries. My thought is basically this; What benefit does the U.S. really receive if the European constitution does not get voted in.
Posted by: David Andrew Taylor at June 1, 2005 9:30 PM